1. Outline – Tues May 30 Online survey Quiz for Chap. 15 Chap. 11 review
Chap. 11 Appendix
Market Structures Review
Game
Options/Make-up Quiz

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3. Quiz Chap. 15
3) A patent or copyright is a barrier to entry based on private industry action to encourage research and development of new products.
False – It’s based on government action, not private industry.

4. Quiz Chap. 15
5) Unlike perfect and monopolistic competition, a monopolist’s demand curve is equal to the market demand curve for the product.
True – since the monopolist is the only seller in the market, then it’s demand curve is the same as the whole market’s demand curve.

5. Chapter 11 Economics 6th edition Technology, Production, and Costs
Copyright © 2017 Pearson Education, Inc. All Rights Reserved

6. 11.1 Technology: An Economic Definition
Define technology and give examples of technological change.
The basic activity of a firm is to use inputs, for example
Workers,
Machines, and
Natural resources
…to produce outputs of goods and services.
Technology: The processes a firm uses to turn inputs into outputs of goods and services.
Technological change: A change in the ability of a firm to produce a given level of output with a given quantity of inputs.

7. 11.2 The Short Run and the Long Run in Economics
Distinguish between the economic short run and the economic long run.
Short run -- a period of time during which at least one of a firm’s inputs is fixed.
Example: A firm might have a long-term lease on a factory that is too costly to get out of.
In the long run, the firm can vary all of its inputs, adopt new technology, and increase or decrease the size of its physical plant.

8. Fixed, Variable, and Total Costs
The division of time into the short and long run reveals two types of costs:
Variable costs are costs that change as output changes
Fixed costs are costs that remain constant as output changes.
In the long run, all of a firm’s costs are variable, since the long run is a sufficiently long time to alter the level of any input.
Total cost is the cost of all the inputs a firm uses in production:
Total cost = Fixed cost +Variable cost
𝑇𝐶 = 𝐹𝐶 + 𝑉𝐶

9. Explicit and Implicit Costs
Recall that economists like to consider all of the opportunity costs of an activity; both the explicit costs and the implicit costs.
Explicit cost: A cost that involves spending money
Implicit cost: A nonmonetary opportunity cost
The explicit costs of running a firm are relatively easy to identify: just look at what the firm spends money on.
The implicit costs are a little harder; finding them involves identifying the resources used in the firm that could have been used for another beneficial purpose.
Example: If you own your own firm, you probably spend time working on the firm’s activities. Even if you don’t “pay yourself” explicitly for that time, it is still an opportunity cost.

10. Which are explicit costs? …implicit costs?
Pizzaria Costs
Amount
Pizza dough, tomato sauce, and other ingredients
$20,000
Wages
48,000
Interest payments on loan to buy pizza ovens
10,000
Electricity
6,000
Lease payment for store
24,000
Forgone salary
30,000
Forgone interest
3,000
Economic depreciation
Total
$151,000
Which are explicit costs? …implicit costs?
Which are fixed costs? …variable costs?

11. Quantity of Workers
Quantity of Pizza Ovens
Quantity of Pizzas per Week
Cost of Pizza Ovens (Fixed Cost)
Cost of Workers (Variable Cost)
Total Cost of Pizzas per Week
Cost per Pizza (Average Total Cost) 2
$800 $0 — 1
200
800
650
1,450
$7.25
450
1,300
2,100
4.67 3
550
1,950
2,750
5.00 4
600
2,600
3,400
5.67 5
625
3,250
4,050
6.48 6
640
3,900
4,700
7.34
If we divide the total cost of the pizzas by the number of pizzas, we get the average total cost of the pizzas.
For low levels of production, the average cost falls as the number of pizzas rises; at higher levels, the average cost rises as the number of pizzas rises.

12. Figure 11.1 Total Cost and Average Total Cost at Jill Johnson’s Restaurant (2 of 2)
The “falling-then-rising” nature of average total costs results in a U-shaped average total cost curve.

13. Table 11.3 The Marginal Product of Labor at Jill Johnson’s Restaurant (2 of 2)
Quantity of
Workers
Pizza Ovens
Pizzas
Marginal Product
of Labor 2 — 1
200
450
250 3
550
100 4
600 50 5
625 25 6
640 15
Additional workers add to the potential output but not by as much. Eventually they start getting in each other’s way, etc., because there is only a fixed number of pizza ovens, cash registers, etc.
Law of diminishing returns: At some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline.

14. Figure 11.2 Total Output and the Marginal Product of Labor
Graphing the output and marginal product against the number of workers allows us to see the law of diminishing returns more clearly.
The output curve flattening out, and the decreasing marginal product curve, both illustrate the law of diminishing returns.

15. 11.4 The Relationship between Short-Run Production and Short-Run Cost
Explain and illustrate the relationship between marginal cost and average total cost.
We have already seen the average total cost: total cost divided by output. We can also define the marginal cost as the change in a firm’s total cost from producing one more unit of a good or service: 𝑀𝐶= ∆𝑇𝐶 ∆𝑄 Sometimes ∆𝑄=1, so we can ignore the bottom line, but don’t get in the habit of doing that, or you’ll make mistakes when quantity changes by more than 1 unit.

16. Figure 11.4 Jill Johnson’s Marginal Cost and Average Cost of Producing Pizzas
Quantity of
Workers
Pizzas
Marginal
Product
of Labor
Total
Cost of
Average
Total Cost
of Pizzas –
$800 1
200
1,450
$3.25
$7.25 2
450
250
2,100
2.60
4.67 3
550
100
2,750
6.50
5.00 4
600 50
3,400
13.00
5.67 5
625 25
4,050
26.00
6.48 6
640 15
4,700
43.33
7.34
We can visualize the average and marginal costs of production with a graph.
The first two workers increase average production and cause cost per unit to fall; the next four workers are less productive, resulting in high marginal costs of production.
Since the average cost of production “follows” the marginal cost down and then up, this generates a U- shaped average cost curve.

17. 11.5 Graphing Cost Curves
Graph average total cost, average variable cost, average fixed cost, and marginal cost.
We know that total costs can be divided into fixed and variable costs:
TC = FC + VC
Dividing both sides by output (Q) gives a useful relationship:
TC / Q = FC / Q + VC / Q
The first quantity is average total cost.
The second is average fixed cost: fixed cost divided by the quantity of output produced.
The third is average variable cost: variable cost divided by the quantity of output produced.
So, ATC = AFC + AVC

18. Figure 11.5 Costs at Jill Johnson’s Restaurant (2 of 2)
This results in both ATC and AVC having their U-shaped curves.
The MC curve cuts through each at its minimum point, since both ATC and AVC “follow” the MC curve.
Also notice that the vertical sum of the AVC and AFC curves is the ATC curve.
And because AFC gets smaller, the ATC and AVC curves converge.

19. Appendix: Using Isoquants and Isocost Lines to Understand Production and Cost
Use isoquants and isocost lines to understand production and cost.
Suppose a firm has determined it wants to produce a particular level of output. What determines the cost of that output?
Technology
In what ways can inputs be combined to produce output?
Input prices
What is the cost of each input compared with the other? That is, what is the relative price of each input?

20. Figure 11A.1 Isoquants (1 of 3)
If a firm’s technology allows one input to be substituted for the other in order to maintain the same level of production, then many combinations of inputs may produce the same level of output.
The pizza restaurant might be able to produce 5,000 pizzas with either
6 workers and 3 ovens; or
10 workers and 2 ovens.
An isoquant is a curve showing all combinations of two inputs, such as capital and labor, that will produce the same level of output.

21. Figure 11A.1 Isoquants (2 of 3)
More inputs would allow a higher level of production; with 12 workers and 4 ovens, the restaurant could produce 10,000 pizzas.
A new isoquant describes all combinations of inputs that could produce 10,000 pizzas.
Greater production would require more inputs.

22. Figure 11A.1 Isoquants (3 of 3)
The slope of an isoquant describes how many units of capital are required to compensate for a unit of labor, keeping production constant.
Known as marginal rate of technical substitution (MRTS)
Between A and B, 1 oven can compensate for 4 workers; the MRTS=1/4.
Additional workers are poorer and poorer substitutes for capital, due to diminishing returns; so the MRTS gets smaller as we move along the isoquant, giving a convex shape.

23. Figure 11A.2 An Isocost Line
Combinations of Workers and Ovens with a Total Cost of $6,00
Point
Ovens
Workers
Total Cost A 6
(6$1,000)+(0$500)=$6,000 B 5 2
(5$1,000)+(2$500)=$6,000 C 4
(4$1,000)+(4$500)=$6,000 D 3
(3$1,000)+(6$500)=$6,000 E 8
(2$1,000)+(8$500)=$6,000 F 1 10
(1$1,000)+(10$500)=$6,000 G 12
(0$1,000)+(12$500)=$6,000
Figure 11A.2 An Isocost Line
For a given cost, various combinations of inputs can be purchased.
The table shows combinations of ovens and workers that could be produced with $6,000, if ovens cost $1,000 each and workers cost $500 each.

24. Figure 11A.2 An Isocost Line
Input combinations that could be produced with $6,000, if ovens cost $1,000 and workers cost $500.
Isocost line: All the combinations of two inputs, such as capital and labor, that have the same total cost.

25. Figure 11A.3 Position of the Isocost Line
With more money, more inputs can be purchased.
The slope of the isocost line remains constant, because it is always equal to the price of the input on the horizontal axis divided by the price of the input on the vertical axis, multiplied by -1.
The slope indicates the rate at which prices allow one input to be traded for the other: here, 1 oven costs the same as 2 workers:
slope = -1/2.
Ovens = $1,000 each
Workers = $500 each

26. Figure 11A.4 Choosing Capital and Labor to Minimize Total Cost
Suppose the restaurant wants to produce 5,000 pizzas.
Point B costs only $3,000 but doesn’t produce 5000 pizzas.
Points A, C, and D all produce 5,000 pizzas.
Point A is the cheapest way to produce 5,000 pizzas; the isocost line going through it is the lowest.
At Point A, the slope of the isoquant and isocost line are equal.

27. Figure 11A.5 Changing Input Prices Affects the Cost-Minimizing Input Choice
If prices change, so does the cost-minimizing combo capital and labor.
Suppose we open a pizza franchise in China, where ovens are more expensive ($1,500) and workers are cheaper ($300). The isocost lines are now flatter.
To obtain the same level of production, we would substitute toward the input that is now relatively cheaper -- workers.

28. What is the combination of inputs that produces 200 apple pies at the lowest cost?
A) combination e: 10 hours of labor and 48 units of capital
B) combination f: 40 hours of labor and 24 units of capital
C) combination g: 60 hours of labor and 14 units of capital
D) combination h: 60 hours of labor and 9 units of capital B

29. Suppose Hilda hires labor at $8 per hour and capital costs $10 per unit. What is the minimum cost of producing 200 apple pies?
A) $3,600
B) $1,120
C) $592
D) $560 D

30. A; 24 – 14 = 10 (capital) 20 – 10 = 10 ( labor) MRTS = 10 / 10 = 1
Suppose Hilda produces 100 apple pies. What is the marginal rate of technical substitution of labor for capital when labor is increased from 10 to 20 hours?
A) 1 unit of capital
B) 10 units of capital
C) 14 units of capital
D) 24 units of capital
A; 24 – 14 = 10 (capital)
20 – 10 = 10 ( labor)
MRTS = 10 / 10 = 1

31. Table 12.1 The Four Market Structures
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Type of product
Identical
Differentiated
Identical or differentiated
Unique
Ease of entry
High
Low
Entry blocked
Examples of industries
Growing wheat
Poultry farming
Clothing stores
Restaurants
Manufacturing computers
Manufacturing automobiles
First-class mail delivery
Providing tap water
More Competitive
Less Competitive

32. 13.4 Comparing Monopolistic Competition and Perfect Competition
Compare the efficiency of monopolistic competition and perfect competition.
Last chapter we learned that perfectly competitive firms achieved two types of economic efficiency.
Productive efficiency refers to producing items at the lowest possible cost. (minimum pt of ATC curve)
Allocative efficiency refers to producing all goods up to the point where the marginal benefit to consumers is just equal to the marginal cost to firms. [MC = MB (demand curve)]
 Monopolistic competition results in neither productive nor allocative efficiency.

33. Figure 13.6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition (1 of 2)
In panel (a), a perfectly competitive firm in long-run equilibrium produces at QPC, where price equals marginal cost and average total cost is at a minimum. The perfectly competitive firm is both allocatively efficient and productively efficient.

34. Figure 13.6 Comparing Long-Run Equilibrium under Perfect Competition and Monopolistic Competition (2 of 2)
Monopolistically competitive firms in panel (b) produce the quantity where MC=MR. The marginal benefit to consumers is given by the demand curve, so MC≠MB: not allocatively efficient.
And average cost is above its minimum point: not productively efficient.

35. The market for smartphones is initially perfectly competitive.
Figure 15.4 What Happens if a Perfectly Competitive Industry Becomes a Monopoly? (1 of 2)
The market for smartphones is initially perfectly competitive.
Price is PC, quantity traded is QC.
In (b), the market is supplied by a single firm. Since the single firm is made up of all of the smaller firms, the marginal cost curve for this new firm is identical to the old supply curve.

36. Figure 15.4 What Happens if a Perfectly Competitive Industry Becomes a Monopoly (2 of 2)
But the new firm maximizes market profit, producing the quantity where marginal cost equals marginal revenue (MC = MR).
This quantity (QM) is lower than the competitive quantity (QC)…
… and the firm charges the corresponding price on the demand curve, PM. This price is higher than the competitive price, PC.

37. Monopoly – Compared to other market structures
Maximizes profit at MR = MC
Same as perfect and monopolistic competition
Monopoly’s demand curve is the same as the market demand curve for the product.
Different than perfect and monopolistic competition
Monopolies are price makers
Perfect competition – price takers
No distinction b/w short run and long run for a monopoly and consequently monopolists can continue to earn profits in the long run (b/c blocked entry to new firms)